Spotify IPO Case - CASE PDF

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Spotify Technology: Beyond Traditional IPO

ROSIE CHEE RAJESH VIJAYARAGHAVAN

Spotify Technology: Beyond Traditional IPO Background

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Founded in 2008, Spotify Technology is a Swedish company that provides music streaming service to over 65 regions worldwide. Its platform, Spotify, provides access to over 35 million tracks and the contents are obtained through royalty partnerships with major record labels as well as independent artists. As of December 31, 2017, Spotify acquired 159 million monthly active users and amongst those users, 71 million are subscribers to premium features (Exhibits 4 and 5). 1

Daniel Ek, CEO and Co-Founder of Spotify, first developed the business idea in 2006 with Martin Lorentzon, a Swedish entrepreneur who acquired one of Ek’s earlier ventures. The music industry at the time suffered from significant losses in revenues and album sales due to music piracy, particularly over the internet. According to data collected in 10 major music markets (including Germany, UK, and the US) by the International Federation of the Phonographic Industry (IFPI), nearly 20 billion songs were illegally downloaded in 2005 alone. With increasing legal concerns, Spotify entered the market to provide a secure and licensed online music streaming service that benefits both users and artists. Spotify operates on a freemium model where it provides basic features for free and requires additional or premium features to be unlocked via paid subscriptions. In addition to transactions of premium services, Spotify generates revenue through displaying third-party advertisements on its platform (Exhibit 7). Differing from a traditional transaction in the music industry where a fixed price is paid to the artists for CD and download sales, Spotify pays royalties to the copyright holders. Approximately 70% of the company’s total revenues are expensed as royalty fees to its copyright holders and the average payout per-play ranges between $0.006 and $0.008 depending on the user’s country as well as the specific artist’s royalty rate. 2

Spotify’s growth strategies are focused on the optimization of technology and to acquire larger user base in both current and new markets. On February 28, 2018, Spotify announced its decision to pursue an IPO and will trade on the New York Stock Exchange as SPOT. *

"Spotify Technology S.A. Announces Financial Results for Second Quarter 2018". Spotify Investors. 26 July 2018. Retrieved 26 July 2018.

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"How is Spotify contributing to the music business?". Spotify. Archived on 3 November 2014. Retrieved 7 November 2016.

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Rosie Chee (BCom/BA 2020) and Professor Rajesh Vijayaraghavan at the UBC Sauder School of Business prepared this case solely as the basis for class discussion. This case was developed from public sources.

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Spotify Technology: Beyond Traditional IPO

The Decision: Pursuing an IPO What is an IPO? An initial public offering (IPO) is the first time a privately-owned company offers the sale of securities to the general public. The company then becomes a public company listed on the stock exchange and therefore, an IPO is also known as the process of “going public”. Prior to an IPO, a company generally has a smaller number of shareholders and limited access to additional capital. An IPO expands the opportunity for a private company to raise capital as it opens itself to a large pool of potential investors. The cash proceeds from the IPO increase the working capital, and be invested in areas such as operations, debt repayments and future expansions. In addition to the benefit of increasing assets, an IPO can generate greater awareness for the company and serves as a tool for brand development.

Key IPO Components 1. Selection of Underwriter When a private company decides to pursue an IPO, the first step is to select an investment bank to act as the underwriter who acts as a broker between the company and the public in the issuance of initial shares. The underwriting fee is dependent on the gross proceeds raised by the IPO and this expense is generally 5%-7% of this value. 2. Due Diligence and Filings The preparation of registration statements is a technical and time-consuming component of the IPO process. In the US, the Securities and Exchange Commission (SEC) regulates the IPO filing as it is responsible for protecting investors and to maintain order in the securities markets. To proceed with an IPO, the issuing company must provide documentations specified by the SEC form and comply with SEC rules. For example, the issuing company must validate 2-3 years of audited financial statements that follow US GAAP or IFRS. The prospectus is also an important legal document required by the SEC that contains the details of an investment offering to the public. It entails information relating to areas such as company operations, financial data, number of available shares, and potential risks associated with the investment. 3. Roadshow A roadshow is the process of visiting potential investors to generate interest and to gather the prices they are willing to pay for the IPO. Underwriters and the management of the issuing company prepare presentations to introduce offering details and to address any questions that potential stakeholders may pose. The audience of a roadshow are generally long-term or preferred clients of the investment bank in charge of the IPO, and they receive insider information prior IPO date. In addition to generating interest, the underwriters gather prices that potential investors are willing to pay and use this information to set an appropriate price for the offering. 4. Pricing On the day before the effective date, the date when shares can be publicly traded on the stock exchange, the underwriter will determine the price at which the shares will trade at. 2

Spotify Technology: Beyond Traditional IPO

The price is decided based on a variety of factors such as the company’s goal, economic condition, level of investment interest – which ultimately leads to the level of demand for the company shares. 5. Price Stabilization Once initial shares are issued, investment banks and underwriters must ensure a stable transition from a predetermined price to a pure market-determined share price. Mechanisms may be used to stabilize the initial pricing.

What did Spotify do Differently? On April 3, 2018, Spotify began trading its shares listed on the New York Stock Exchange (NYSE). However, Spotify did not sell any shares of stock. The company did not raise any capital through the issuance of new shares on the first day. The shares could only be traded if its existing shareholders are willing to sell. Therefore, the proceeds of the offering will only be cashed by existing shareholders. In addition to the absence of share issuance, there was also no underwriting, specified offering price set by an underwriter, nor stabilization mechanisms that supports the post-IPO stock price. The selection of an underwriter is the first step in a usual IPO decision. Despite not having an underwriter, Spotify hired Goldman Sachs, Morgan Stanley, and Allen & Co to advise on their public listing on the NYSE. By avoiding the underwriting process, Spotify reduced a significant amount of expenditure as a typical underwriting fee costs 5%-7% of gross proceeds raised from the IPO. With the absence of underwriting, there were also no underwriters setting the price at which the shares will be sold at. Spotify left the price setting power to the market upfront, allowing demand and supply set the price, but incurring higher risks of uncertainty and volatility. The traditional roadshow transformed into a public event called “Investor Day”, with presentations livestreamed on the internet. Explained by Daniel Ek in an interview, the purpose of these unconventional procedures was to eliminate information asymmetry and to ensure transparency to all stakeholders.

New Path to IPO? Despite there being precedents, the IPO approach that Spotify adopted is uncommon and entrepreneurs in the tech industry are closely watching its success. If Spotify demonstrates that most of the IPO apparatus is unnecessary, companies seeking to go public could customize their process while eliminating major pain points of the traditional path. The methodology in the pursuance of IPO depends on the situation of the company, and Spotify was in a unique position in a number of ways. First, Spotify had an already established brand name, making it easier to attract institutional investors without the connections of an underwriter and promotions through roadshows. Second, while most companies seek to raise additional capital through selling new shares, Spotify did not issue new shares as it was primarily interested in allowing existing shareholders to freely trade their shares in the market. Third, the company’s shares were already actively traded in the private market and therefore, the absence of an underwriter to set and control price did not lead to high price volatility in the first few weeks of trading.

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Spotify Technology: Beyond Traditional IPO

With the absence of certain traditional IPO apparatus, a company faces numerous challenges including generating awareness, raising capital, and risks associated with market price volatility. Spotify’s company situation and IPO goals prevented several risks accompanied by this innovative approach, making this process work for the music streaming giant. Whether this approach is a tailored fit for Spotify or if it paves a new path towards the future of IPO, remains a question for the future to answer.

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Spotify Technology: Beyond Traditional IPO

Exhibit 1

Consolidated Statement of Financial Position

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

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Spotify Technology: Beyond Traditional IPO

Exhibit 2

Summary of Consolidated Financial and Other Data

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

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Spotify Technology: Beyond Traditional IPO

Exhibit 3

Sale Price History of Ordinary Shares

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

Exhibit 4

Monthly Active Users (MAU)

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

Exhibit 5

Premium Subscribers by Region

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Spotify Technology: Beyond Traditional IPO

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

Exhibit 6

Premium Churn

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

Exhibit 7

Advertising Solutions to Partners

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Spotify Technology: Beyond Traditional IPO

Source: SEC, 2018. Form F-1 Registration Statement, Spotify Technology S.A.

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